Former Fed chief warns that nation is facing 'huge imbalances and risks'

Paul Volcker, former chairman of the Federal Reserve, said that the nation is consuming more than it is producing and that Social Security and Medicare are threatened by the retirement of baby boomers.

While the improving U.S. economy remains the engine of growth for the world economy, an underlying trend involving "huge imbalances and risks" should be cause for serious alarm, Paul Volcker warned Feb. 11 during a speech on campus. Americans have virtually no savings, the former chairman of the Federal Reserve said, and the nation is consuming more than it is producing. Furthermore, Social Security and Medicare are threatened by the retirement of millions of baby boomers and skyrocketing health care costs. More broadly, he continued, the world economy is lopsided.

"Altogether, the circumstances seem as dangerous and intractable as I can remember," Volcker said during a keynote address at the second annual summit of the Stanford Institute for Economic Policy Research. "But no one is willing to understand [this] and do anything about it."

Volcker spoke at the end of a daylong conference that attracted about 450 corporate leaders, entrepreneurs, policymakers and academics. The event included discussions on the stability of the global economy, the U.S. economic outlook and the role of the Internet in helping to level the competitive playing field worldwide. The conference also featured sessions on outsourcing, Medicaid and Medicare, technology policy and the Sarbanes-Oxley Act, which was implemented in 2002 to restore investor confidence in corporate America following a series of bankruptcies and far-reaching accounting scandals.

During a morning session, William Perry, a former secretary of defense and a senior fellow at the Stanford Institute for International Studies, gave a chillingly stark assessment of the crisis of terrorism that was reinforced by George Shultz, a former secretary of state.

"I fear that we're headed toward an unprecedented catastrophe where a nuclear bomb is detonated in an American city," Perry said. "The bomb will not come in a missile at the hands of a hostile nation. It will come in a truck or a freighter at the hands of a terror group."

Perry, who holds the Michael and Barbara Berberian Professorship, said the "awesome military capability" of the United States has had unintended consequences in that it has increased the incentive for a hostile power, unable to compete in conventional warfare, to acquire weapons of mass destruction and launch terror attacks against America. U.S. military superiority is not particularly effective against such tactics, he said. "There exist terror groups, of which al Qaeda is the most prominent, that have the mission, the intent to kill Americans," Perry said. "They have the capability to do so; they have the resources to do so." A truly nightmare scenario would involve a terror group using nuclear weapons acquired clandestinely, he said: "After 9/11 that threat seems all too real."

Such a catastrophe is preventable, but the United States is not taking the necessary measures to avert it, Perry warned. Important steps should include a major expansion of the Nunn-Lugar Cooperative Threat Reduction Program with the support the G-8 group of industrialized nations. The program was created in 1991 to reduce the threat posed by the legacy of the Soviet nuclear arsenal and succeeded in dismantling and destroying weapons in Kazakhstan, Ukraine and Belarus. Furthermore, Perry said, a clear strategy of "coercive diplomacy" should be used against North Korea and Iran, followed by a major diplomatic initiative to convince other nuclear powers that the threats posed by terrorists are real and not just directed at Americans. "While America must show real leadership in dealing with this problem, [it] cannot deal with it alone," he said.

Shultz, the Thomas W. and Susan B. Ford Distinguished Fellow at the Hoover Institution, said the United States faces a huge problem in combating Islamic radicals intent on using terror to achieve their goals. "Eventually, what they want is to change the way the world works by creating a unified Islamic theocratic state," he said. "It's a worldwide agenda."

Shultz argued that the United States must help supporters of mainstream Islam understand the fundamental nature of the problem so they will take action against the radicals themselves.

"That's why Iraq is of such overwhelming importance," he said. "Here we have a country in the heart of the Middle East where there is a chance. If Iraq can emerge as a sensibly governed country—that's a gigantic event in the Middle East and in this war on terror. Our enemies recognize that just as well as we do, and that's why we're having so many problems."

Other measures that Shultz said should receive greater support include efforts to set up independent media in countries such as Iraq, as well as a revival and expansion of the U.S. diplomatic service, which he said was allowed to atrophy after the end of the Cold War. "We have developed an awesome military capability," he said. "We need a diplomatic capability that is as every bit as good." Shultz also stressed the need to reduce U.S. dependence on foreign oil. "We are out of our cotton-picking minds not to be doing much, much more to figure out how to use much, much less oil," he said to applause from the audience.

In the afternoon, Thomas Friedman, a columnist at the New York Times, also called for greater efforts to develop alternative energy supplies. This should be the "moon shot of our generation," he said.

Friedman discussed how the convergence of personal computers, cheap telecommunication and workflow software has changed the way the world works. In his upcoming book, The World Is Flat: A Brief History of the 21st Century, Friedman explained that the world has shrunk to the point where individuals, not countries or companies, are increasingly able to think and act globally. "And it's not just a bunch of white Westerners," he said. "It's going to be driven by individuals of every color of the rainbow."

Friedman told the audience that these technological advances quietly unfolded just as the 9/11 terror attacks, the Enron collapse and the dot-com bust grabbed America's attention. "People thought globalization was over but actually it turbo-charged globalization; it drove it overseas," he said. "9/11 completely distracted our administration, and then there was Enron. We have hit a fundamentally transformative moment and no one is talking."

In this new scenario, people anywhere in the world will be able to "innovate and not emigrate" if they have the required skills, Friedman said. This means that engineers in India and China will be able to compete on a level playing field with people in this country. "When the world goes flat, everything changes," he said.

To address this challenge, Friedman said the United States must radically improve science, mathematics and engineering education and encourage young people to enter these fields. "We're not doing that," he said. "In the next two years, five years, it won't matter. In 15 years, which is the time it takes to build an engineer, it will matter. We will not be able to sustain our standard of living."